A steep correction is on the cards in the residential real esate space and the wider implication of a slowdown will include a huge stress on the GDP.
Q Your recent thematic report raised the probability of a 50% cut in resident ial real estate prices. Is it the base case scenario, optimistic scenario or pessimistic scenario?
Let us look at it rationally instead of trying to zero in on a specific scenario. We have a situation where residential rental yields are at around 2% at the gross level (including tax and maintenance), while the borrowing cost is around 10%. This implies a 8 percentage point difference between the cost of borrowing and rental yield. You won't find this kind of difference in any other large economy. This alone suggests that residential prices are not in sync with reality.
Q Why are other experts saying a 50% cut in residential real estate prices is not possible now?
Let me clarify that we are not predicting a 50% correction in residential real estate. What we are saying is that the current status quo in real estate is untenable and therefore, we are heading towards a steep correction in residential real estate prices.We used the probability of a 50% correction only to give some sense of the extent of the correction. The actual correction could obviously be more or less than 50%.
Secondly, it is not correct to say that Indian real estate can't correct by 50%. After tripling between 1991 and 1998, Mumbai residential prices fell by 50% between 1998 and 2003. Even if Mumbai house prices halve from current levels, the rental yield will go up only to 4%, still far from the cost of borrowing. So the actual correction may be more than 50%. Futher, there are several other real estate markets like Dubai that regularly see corrections close to 50% then a big rally again followed by a correction.
Q Rental yields may be close to the cost of borrowing for most real estate markets, but Indian rental yields were always below cost of borrowing.
Indian rental yields have been below the cost of borrowing firstly because of the emotional benefits of owning a home. Indians prefer to stay in owned homes. The second reason is use of real estate to park black money. The black money component has come down in real estate transactions now because of the hike in ready reckoner prices by several states. Ready reckoner rates are now close to market rates. Thus the main factor, black money, that justified low rental yield in the past is no more applicable. As the PM's effort to curb black money start yielding results, real estate will see significant correction.
Q RBI is expected to cut rates in coming quarters. Won't that act as a support for real estate prices?
Given the magnitude of difference between the rental yield and the cost of borrowing, 25 or 50 bps here or there is unlikely to make a significant difference in the quantum of correction we will see. So the discussion about whether the RBI will cut rates or whether the banks will pass it on to borrowers are secondary issues.
Q Will this correction be widespread or will there be some pockets that will be able to buck the trend?
In a bear market, not every stock falls. Similarly in a broad-based real estate correction, it is not necessary that every city has to go down. If you take the top 10 cities, perhaps Bangalore can hold up. Further, even for cities which will see a correction, there will be certain pockets more or less exposed than others. For example, within NCR, it is well known that Gurgaon and Noida are more exposed than others.
Q What about commercial realty?
The problem is not that acute with commercial realty as commercial rental yields are at more sensible levels thanks to commercial prices sliding over the last 3-5 years. Due to more pronounced price correction in commercial realty, the supply overhang in commercial is also less compared to residential.
Q How will the real estate slowdown hit the GDP?
The macro implications of real estate correction are far more substantial than what people understand. Real estate is a mega sector and around half of India's capex comes from it. Further, real estate is the biggest employer after agriculture.
The real estate slowdown has already started impacting rural wage growth and consumption. Rural consumption is already under pressure because of the modest increase in food grains' minimum support prices for two years in a row and also because of a global fall in cash crop prices.This problem is being compounded because of the reverse migration of unemployed construction workers from cities.
Real estate capex is around 15% of GDP and rural consumption is around 25% of GDP. So 40% of our GDP is under stress now on the back of real estate correction. These are powerful macro-economic downdrafts.Therefore, our GDP growth forecast for 2015-16 is only 7%, lower than the 7.3% growth recorded in 2014-15. Our 7% estimate for this year is also significantly lower than the government's estimate of 8% and the prevailing consensus estimate of 7.8%.
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